What is Elliott Wave Theory?
Elliott Wave theory is not a market indicator or predictor. It is a market descriptor and describes how prices behave with a defined set of rules and guidelines, 90 in total (45 rules and 45 guidelines). Apply these rules/guidelines and it becomes a game of deductive reasoning of what can happen and what cannot.
Like the game of chess, financial markets have multiple potential outcomes. If you assume your opponent has only one path for his/her choices while playing chess, you will most certainly lose. To be successful, you must see the multiple potential sequences that can occur and then systematically deduct what is possible to make the best move(s) as the game plays out.
Similarly, when practicing Elliott Wave theory, you should have multiple wave counts in order from most probable to least probable. As more price information becomes known, the possibilities will narrow and decisions (bets) can be made on the most probable. Other technical indicators can be used to better assign probability and/or configure your confidence level of the decision.
Applying Elliott Wave Theory to Live Cattle Futures
Below we have the two most probable Elliott wave counts at this point in the Live Cattle futures market. For the sake of time and space, we will only address the two most probable. However, other wave counts may arise as new price information becomes available. This is where defined critical support and resistance comes into play.
Often, when you have multiple wave counts that differ in long-term direction but agree on the short-term direction, you can be more confident that the short-term forecast is correct.
The first interpretation suggests that the intermediate trend is up, but ready for a pullback. The forecast calls for prices to top out near current levels and retrace 50-62% of the initial rally of wave A. Because wave A took about 4-5 weeks to develop, expectations for the wave B retracement would be that we target $104-$106 in the next 2 weeks. Once that is attained, we should see further rally in wave C of II in November.
Live Cattle Wave Interpretation #1
The second interpretation suggests that the intermediate trend is down and that once this rally is complete in the very near future, we should see much lower prices. Expectations are that this market makes a new price low before the year is complete. Critical resistance for this interpretation is defined.
Live Cattle Wave Interpretation #2
Determining the Optimal Elliott Wave Count
We can gain confidence in taking long risk off the table or perhaps staying inherently short (if you are a buyer) because they agree on short-term movement being lower, even though the 2 interpretations differ in the long-term. There is double bearish divergence in momentum and price on the hourly chart. That screams snap back. If that move occurs, additional price information will allow us to apply the rules and guidelines of Elliott Wave theory. Only then can we deduce the most probable path for prices.
Currently, we put the greatest probability on the first interpretation for the following reasons:
On the daily chart, the most recent price high was accompanied by the greatest momentum. Typically, we should see another new high (after a pullback) that has weaker momentum. This builds the case for interpretation #1.
Looking at the RSI-Stochastic chart, we can see that RSI has established itself well above the bear market resistance line of 60. This typically implies that the preceding downtrend is complete. What we would like to see is that the market pulls back in price and RSI retreats to the 40-50 level, but holds. That would add confidence that another wave up is on the horizon.
We can see a long-term buy signal took place in the last couple weeks on the weekly continuous MACD chart. To illustrate how reliable this indicator has been, I marked the previous times this indicator has shown itself (going from negative to positive on the histogram) with black arrows. The vertical, gold lines marks the week of the indicator turning to a buy. That track record is pretty good.
Any excess long risk should be taken off the table after a 16% rally over the course of 26 trading days.